Are buyout firms a threat to the corporate world?

17 February 2020

Democratic presidential hopeful Elizabeth Warren has recently joined numerous other politicos in the US and the UK who over the years have slammed buyout firms as “vampires” sucking the blood from the corporate world. She has even published proposed legislation to be enacted if she is elected which does not mince its words: The Stop Wall Street Looting Act. Could a slimmed down version of this proposal gain support in the UK, despite the election of the more pro-business Conservatives?

Warren’s attack on the industry has proved somewhat popular because of the bankruptcy of several private equity-owned businesses. In particular, retailers have been affected with critics claiming that cash was paid out to the shareholders and replaced with high levels of debt. When failure came, the main losers were the lenders and the employees. Warren’s bill would propose the removal of both the carried interest ‘loophole’ and the favourable tax treatment of debt, as well as a restriction on the fees payable to private equity owners. However, the main focus of her proposal is to force buyout firms to take on the liabilities of portfolio companies that run into trouble. Many in the industry believe that this will be the beginning of the end for private equity and comment that it is a clear assault on the concept of limited liability that has been one of the basic principles of our financial system for several hundred years.

Buyout firms under attack

Buyout firms strongly feel that it is unfair to attack the whole industry because of a few unscrupulous participants. Many of the buyout firms have worked on significantly reducing the levels of debt in portfolio companies and bankruptcies are rare, albeit the well-known ones receive lots of press when they happen. Critics, on the other hand, counter claim that those firms acting sensibly will not be overly affected by the new proposals, as they will be centred on containing abuses carried out by the less professional operators. The proposals would not for example affect Warren Buffett’s Berkshire Hathaway or 3i, who buy businesses through an insurance company and/or use their own balance sheets. That said, the changes would clearly hit the profitability of the firms as well as the personal finances of their partners, so it is no surprise that most of the industry is currently very unhappy with the proposals.

There is a general consensus that some of the key players in the buyout industry have not always done enough to help outsiders understand what they actually do and the benefits that such investment can bring. We see this quite frequently when we discuss equity investment options with clients and prospects, who sometimes refer, tongue in cheek but somewhat disappointingly, to ‘vulture capitalists’ rather than venture capitalists. Many business owners read about the high-profile failures, of which there are genuinely not many, but they are not equally aware of the many success stories. Their desire to speak to private equity investors and/or venture capitalists is often quite low and those working in the industry could do more to address this. Equity investments into a well-managed business with a clear growth plan and exit strategy, where the owners and the investors are on the same page, communicate well and support each other’s differing skillsets, invariably prove to be a success. There are too many financially independent private equity practitioners and ex business owners for this not to be the case.

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This article was published in a recent edition of our Corporate Finance Newsletter.

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